Edited version of private advice

Authorisation Number: 1051586763956

Date of advice: 9 October 2019

Ruling

Subject: Dividend stripping and general anti-avoidance

Question 1

Is the Scheme a dividend stripping operation under section 207-155 of the Income Tax Assessment Act 1997 (ITAA 1997) or a scheme for the stripping of company profits within the meaning of subsection 177E(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Will Part IVA of the ITAA 1936 apply to deny a tax benefit resulting from the Scheme?

Answer

No

Question 3

Will the distribution paid to the shareholders in XYZ Pty Ltd be treated as a distribution under section 47 of the ITAA 1936?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 2019

Relevant facts and circumstances

The Company

XYZ Pty Ltd is a private company that was founded in 19XX. It has one class A share, one Class B share, 50 Class C shares, 50 Class D shares and 50 Class E shares. All the shares have the same rights and value.

The Class A and B shares are owned by the Estate of the Deceased (the Deceased).

The remainder of the shares are owned by the children of the Deceased; Person A, Person B and Person C. They are collectively known as the Individual Shareholders.

Person A owns 50 Class C shares, Person B owns 50 Class D shares and Person C owns 50 Class E shares.

The Individual Shareholders are the three directors of XYZ Pty Ltd, while Person A also functions as the Secretary.

As at 30 June 20XX each share in the company had a value of $XX. There is approximately $XX in listed company shares and units and $XX in cash reserves.

XYZ Pty Ltd only owns investments on a passive basis and has not conducted any trades in the last four years, and does not operate any other business. It has not paid dividends in the last four years.

XYZ Pty Ltd operates under its own constitution and does not rely on the replacement rules of the Corporations Act 2001.

The Individual Shareholders acquired their shares prior to 20 September 1985.

Background

The Deceased had named the Individual Shareholders as executors of the estate, with the residual estate to go to them equally. However, prior to their death, the Deceased executed a codicil that removed Person B as an executor of the estate.

Sometime after the Deceased's death an estrangement occurred in the family, with Person B on one side and Person A and Person C on the other.

Person B wished to separate her financial interests from that of their siblings, including their interests in XYZ Pty Ltd. Discussions were underway between each sides representatives but a dispute arose between Person B and their siblings in their function as executors of the Deceased's estate in relation to the disposal of Person B's shareholding in XYZ Pty Ltd.

The dispute resulted in Court proceedings.

The relationship between Person B and Person A and Person C is extremely strained and all communication is done via their legal representatives.

The Individual Shareholders have reached an in-principle agreement to liquidate XYZ Pty Ltd and distribute its assets in-specie to its shareholders.

The Scheme

The intended steps to effect the division of assets equally is set out below (the Scheme).

A new company (New Co C) will be incorporated to buy the Class C shares Person A owns in XYZ Pty Ltd. Person A will be the sole shareholder in New Co C. They will receive ordinary shares in New Co C in consideration for the disposal of the shares in XYZ Pty Ltd and Person A will choose the rollover under subdivision 122-A of the ITAA 1997.

A new company (New Co D) will be incorporated to buy the Class D shares Person B owns in XYZ Pty Ltd. Person B will be the sole shareholder in New Co D. They will receive ordinary shares in New Co D in consideration for the disposal of the shares in XYZ Pty Ltd and Person B will choose the rollover under subdivision 122-A of the ITAA 1997.

A new company (New Co E) will be incorporated to buy the Class E shares Person C owns in XYZ Pty Ltd. Person C will be the sole shareholder in New Co E. They will receive ordinary shares in New Co E in consideration for the disposal of the shares in XYZ Pty Ltd and Person C will choose the rollover under subdivision 122-A of the ITAA 1997.

The Deceased's estate will not interpose an entity to own the Class A and Class B shares as they wish for the administration of the estate to be finalised.

After New Co C, New Co D and New Co E are interposed (the Interposed Entities), the shareholders will vote to wind up XYZ Pty Ltd through an informal liquidation.

Apart from the cash required to pay the administration costs and tax liabilities of XYZ Pty Ltd, the remaining assets will be distributed on a pro-rata in-specie basis to the shareholders. The Class A and B shareholders will receive cash whereas the Class C, D and E shareholders will receive an in-specie distribution from XYZ Pty Ltd's assets.

If a holding of listed company shares or units is not equally divisible by three, XYZ Pty Ltd will sell enough shares or units from that holding to enable an equal division.

It is estimated by XYZ Pty Ltd's accountants that the expected tax liability for XYZ Pty Ltd will be $XX.

New Co C, New Co D and New Co E will continue to maintain their passive investments and not undertake any trading activities.

Alternative schemes

Due to the estranged nature of the relationship between Person B and, Person A and Person C, they do not agree that the shares held by one party (Person B) be treated any different to the other parties (Person A and Person C).

The following schemes have already been considered and discarded:

(a)  Person A and Person C buying Person B's shares;

(b)  Person B buying Person A and Person C's shares;

(c)  XYZ Pty Ltd buying back Person B's shares;

(d)  XYZ Pty Ltd buying back Person A and Person C's shares;

(e)  a third party (if one could be found) buying Person B; and

(f)   a third party (if one could be found) buying Person A and Person C's shares.

XYZ Pty Ltd's constitution is silent to buying back its shares and in those cases the Corporations Act 2001 requires a member's special resolution at a meeting of members. A special resolution requires at least a 75% approval. Due to the dispute between the Individual Shareholders, who each own enough shares to block this action, it will not be successful.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 47

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 section 207-155

Reasons for decision

Question 1

Is the Scheme a dividend stripping operation under section 207-155 of the ITAA 1997 or a scheme for the stripping of company profits within the meaning of subsection 177E(1) of the ITAA 1936?

Summary

The Scheme is not a dividend stripping operation as defined in section 207-155 of the ITAA 1997 and it is not a scheme by way of or in the nature of dividend stripping within the meaning of subsection 177E(1) because the purpose of the Scheme is not to avoid income tax.

Detailed reasoning

The Commissioner has the discretion to cancel all, or part of, a 'tax benefit' that has been obtained (or would be obtained but for section 177F of the ITAA 1936) by a taxpayer in connection with a scheme to which section 177E of the ITAA 1936 applies.

'Scheme' is defined broadly in section 177A of the ITAA 1936 and, in this case, would include all of the steps that comprise the Scheme to wind down XYZ Pty Ltd and dispose of the remaining assets to the Interposed Entities.

Section 177E of the ITAA 1936 applies to schemes in the nature of, or that have the effect of, dividend stripping. The tax benefit is identified within the section as the amount of profit the Commissioner determines that is stripped from the target company, in this case XYZ Pty Ltd, and would have been included in the Individual Shareholder's assessable income as a dividend out of those profits.

More particularly, section 177E of the ITAA 1936 applies where:

·         a company's property is disposed of under a scheme by way of, or in the nature of dividend stripping, or a scheme having substantially the effect of a scheme by way, or in the nature, of a dividend strip;

·         the Commissioner concludes that the disposal represents in whole or in part a distribution of the company's past, present or future profits; and

·         if immediately before the scheme was entered into, the company notionally paid a dividend out of the profits represented by the disposal of the property, the amount represented by the dividend would have been, or might reasonably be expected to have been, included in the assessable income of a taxpayer.

Section 177E of the ITAA 1936 presupposes the exercise by the target company of its discretion to pay a dividend and then explores the circumstances of the scheme to determine whether it has taken place for the dominant purpose of enabling the target company's shareholders to avoid the tax payable on that dividend.

A distribution will be taken to be made as part of a dividend stripping operation, pursuant to section 207-155 ITAA 1997, if the making of the distribution arose out of, or was made in the course of, a scheme that:

(a)  was by way of, or in the nature of, dividend stripping, or

(b)  had substantially the effect of a scheme by way of, or in the nature of, dividend stripping.

The effect of the Scheme in the winding up of XYZ Pty Ltd is that the assets of XYZ Pty Ltd will be distributed to the Individual Shareholders which will trigger a CGT even A1 for XYZ Pty Ltd. XYZ Pty Ltd will make a capital gain or loss on the transactions based on the market value at the time of distribution. Currently that is estimated at a liability of $XX.

The Interposed Entitles will be liable to tax on the assessable components of the in-specie transfers. The Individual Shareholders will not receive the in-specie distributions but instead will receive shares in their Interposed Entity through the subdivision 122-A of the ITAA 1997 rollovers.

When the Interposed Entities pay dividends to the respective Individual Shareholder they will need to include the franking credits and dividend in their assessable income.

There will be no tax avoided and the Scheme will not constitute a dividend stripping operation under section 207-155 of the ITAA 1997.

After examining the circumstances of the scheme, in particular the interposing of the corporate entities and in-specie distribution, it is considered that it will not be entered into for the dominant purpose of avoiding tax that would otherwise be paid by the Individual Shareholders on a dividend from XYZ Pty Ltd. Rather, the purpose of the scheme is objectively focussed allowing the Individual Shareholders to continue to run their investments as they see fit, without the interference of poor relations between the Individual Shareholders.

For the purposes of section 177E of the ITAA 1936, the proposed transaction is therefore considered not to constitute a scheme in the nature of, or that has the effect of, dividend stripping.

Accordingly, there is no tax benefit obtained by the Individual Shareholders under section 177E of the ITTAA 1936 in respect of which the Commissioner would make a determination under subsection 177F(1) of the ITAA 1936.

Question 2

Will Part IVA of the ITAA 1936 apply to deny a tax benefit resulting from the Scheme?

Summary

Part IVA of the ITAA 1936 does not apply to the Scheme.

Detailed reasoning

Part IVA of the ITAA 1936 is a general anti-avoidance provision that can apply in certain circumstances. Part IVA gives the Commissioner the power to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

In broad terms, Part IVA will apply where the following requirements are satisfied:

·         there is a scheme (see section 177A of the ITAA 1936);

·         a taxpayer has obtained, or would but for section 177F of the ITAA 1936 obtain, a tax benefit in connection with the scheme (see section 177C of the ITAA 1936); and

·         the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b) of the ITAA 1936).

The application of Part IVA depends on a careful weighing of all the relevant facts and surrounding circumstances of each case.

After considering the relevant facts and circumstances and factors in paragraph 177D(b) of the ITAA 1936, Part IVA does not apply to this Scheme.

Question 3

Will the distribution paid to the shareholders in XYZ Pty Ltd be treated as a distribution under section 47 of the ITAA 1936?

Summary

The distribution will be treated as a distribution under section 47 of the ITAA 1936.

Detailed reasoning

During an informal winding up, distributions of cash or other property of a company appropriated to the shareholders are treated as though they are distributions from a liquidator in a formal winding up under section 47(2A) of the ITAA 1936.

Section 47(1) of the ITAA 1936 sets out that amounts distributed by a formal liquidator in the course of winding up a company are deemed to be dividends paid by the company out of profits derived by it to the extent that they represent income derived by the company other than income that has been properly applied to replace a loss of paid-up capital share.

XYZ Pty Ltd will make no formal resolution to wind up the company as the shareholders in XYZ Pty Ltd have made an agreement to informally wind up XYZ Pty Ltd. The amounts paid to the shareholders will be considered assessable distributions under section 47 of the ITAA 1936 insofar as they do not represent income properly applied to make good lost capital.